The most expensive tax mistakes physicians make

In 2020, the median physician salary was $208,000, while the mean American salary stood at $71,400. Though comparatively higher earnings are part of what make the white coat attractive, physicians also tend to fall into higher tax brackets

It's always a good time to review some of the best physician tax practices. While every doctor’s finances are different, there are a few common strategies that can net substantial savings. Failing to follow them can prove costly.

Fully fund retirement accounts

Tax savings begin with retirement savings. When you fund the appropriate retirement accounts, you’re actually paying yourself twice. Your future, retired self nets the initial investment, plus the compounding interest. Meanwhile, in the present, you lower your taxable income.

Most physicians will have access to an employer-sponsored 401(k) or a 403(b) plan, if they work for a nonprofit. Both are tax-deferred accounts, meaning you pay taxes on the money when you make withdrawals in retirement.

Failing to fund your 401(k) or 403(b) is an expensive mistake for two reasons. The first: You’re missing an opportunity to lower your taxable income. The second: Many employers offer matching funds for 401(k) and 403(b) plans up to a specific dollar amount or percentage of income that the employee designates as the contribution. Doctors who don’t fully fund their retirement accounts may be leaving money on the table. 

In 2021, the IRS capped annual 401(k) and 403(b) contributions at $19,500.^[][] Doctors over the age of 50 were able to contribute an additional $6,500 to a 401(k). For physicians working at nonprofits, you’re eligible for catch-up contributions after 15 years of service with the same employer. Your limit goes up by the lesser of:

• $3,000

• $15,000, minus any elective deferrals you made in previous years under this rule

• $5,000, multiplied by your years of service, minus any deferrals made in previous years.

For 2021, the 403(b) elective deferral limit could go up to $22,500.

There are also a couple of other ways to pay yourself twice and recoup some tax savings.

Save for college

Planning on paying for your children’s post-secondary education? Start saving now.

According to one estimate, college education costs increase 6% each year. If your child were to enroll in a private college in 2035, a 4-year degree could come with a $230,000 price tag. 

Failing to fund a qualified tuition program (QTP), also known as a 529 plan, is costly for three reasons.^[] Doctors miss the opportunity to lower their taxable income, they skip a chance at tax-free investment growth, and they likely will feel the sting of rising tuition costs.

States or state agencies manage QTPs. For state-managed investment vehicles, contributions are not deductible from your federal taxes, but many states allow this deduction. Qualified distributions, which include higher-education costs and even certain elementary or secondary school tuitions, are generally tax-free. Note: Plan beneficiaries can direct only $10,000 to loan repayment.

The IRS considers QTP contributions as gifts to the beneficiary, putting the 2021 limit at $15,000.

Fund your HSA

Healthcare savings accounts (HSAs) are practical and offer triple tax savings.^[] Doctors who overlook this tax-savings strategy pay twice: Once for tax dollars wasted, and again when paying for medical expenses that could have been subsidized by an HSA.

For 2021, the IRS allows contributions up to $3,600 for yourself, and $7,200 if your insurance also covers your family. The second tax benefit is tax-deferred growth. Unlike flexible spending accounts (FSAs), HSA funds do not expire, and they carry over from year to year. Finally, when you withdraw money for qualified purchases, you won’t pay taxes. 

HSAs are so tax-friendly that some people use them as a secondary retirement-savings vehicle. After all, you’re more likely to need funds for healthcare as you age. You can even use the funds for nonmedical expenses, but you’ll pay taxes on the amount used—if you’re under the age of 65, you’ll pay a 20% penalty.

Pass-through entities

Self-employed physicians may want to explore the Section 199A deduction.^[] This deduction is generally available to owners of S corporations, sole proprietorships, and partnerships. It’s a substantial deduction if you qualify. 

You may be eligible to deduct 20% of your qualified business income, 20% of qualified real estate investment trust dividends, and income from publicly traded partnerships. 

The calculation process—and whether it’s worth taking the deduction—gets a bit tricky, so it may be worth talking to a CPA about this. Generally speaking, they will calculate the deduction based on whether your taxable income surpasses a certain threshold. 

For 2021 filings, the threshold was $329,800 if filing jointly, or $164,900 if single. Stay below that mark, and your deduction is 20% of your qualified business income.